‘Not in favour of asset sales and haircuts, but turnaround of potential companies’
The asset reconstruction business is still evolving. So there is space for all asset reconstruction companies (ARCs) to recognise their own expertise and enter the space they aspire to be in. One particular ARC is Edelweiss ARC. The company has focused en
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What is your current position and how does it reflect your vision?
Edelweiss ARC started operations in 2010. Today our capital employed is Rs 4,800 crore. The debt-equity ratio is a comfortable 3.7:1. Beyond the funds already deployed, we today have about Rs 10-11,000 crore to be deployed in distressed assets over the next two-three years. These funds will come from the CDPQ, one of North America’s largest pension fund managers and an AIF being raised by Edelweiss Group.
Our focus is very clearly on large cases with operational assets and business potential. Our top twenty cases would account for 65-70 per cent of the AUM, including large assets like Karaikal Port, Binani Cement, Essar Steel etc. The account must be EBITDA positive or should have a case for being EBITDA positive. When we came into this business, there were a dozen of ARCs already in business with primary strategy of recovery. We therefore created a different business which is focused only on revival of distressed cases.
Our first three cases today have turned around and are doing well. Our view is that pricing (of distressed loan takeovers) is not an issue if the asset quality is good. It is not at all essential for banks to take large haircuts, if the business is essentially viable but has had a temporary financial breakdown which can be repaired.
We are agnostic region wise. We tend to avoid certain states like Kerala, Madhya Pradesh, Haryana and Jharkhand, which have high stamp duty (7-12 per cent range) and therefore our transaction costs become high. The last amendment of SARFAESI actually exempted stamp duty for assignment cases, but no state has implemented this policy on the ground as yet, which is disappointing. We understand that the government of India has taken up the issue of stamp duty and registration charges with all state governments. The total AUM figure of Edelweiss ARC was around Rs 38,000 as of March 2017 and it stands at about Rs 43,000 crore now. Steel, cement, textiles, infrastructure, real estate and power are the main sectors which account for 48 per cent of this amount.
What is the thought process of turnaround execution? Could you give a few work examples?
One of our important learning has been the fact that a business loses competent people and talent when financial stress sets in. This led us to start an operational turnaround team within the Edelweiss group. The mandate of this turnaround group is simply to do anything and everything needed to turn the case around. It could be cash monitoring, having operational partnerships, scrutinising CEO/CFO appointments or anything else. This is the extent of our commitment. In case of Adhunik Power, we implemented significant managerial changes with induction of a former NTPC Chairman as Chairman at Board level and putting in place a corporate governance structure. In BILT Graphic and Paper Products, we pumped in Rs 300 crore around a year back and today monthly EBITDA is Rs 40 crore. In both these companies, cash monitoring is also being done. Karaikal Port in 2015, when we took over debt, had an EBITDA of Rs 60 crore which we think would be close to Rs 200 crore for FY2018. There beyond the monitoring, our team also focused on modernisation.
In case of Arshiya International’s case, we estimated that asset was not all that valuable at the Rs 3,000 crore face value of debt, but we arrived at a transaction value of Rs 1,500 crore and there banks took a 50 per cent haircut. There, we firstly restructured the Rs 1,500 crore debt to Rs 1,600 crore at 10 per cent and converted the balance debt to a 25 per cent equity stake which we would hold on behalf of the banks. Within this, Edelweiss ARC will have 15 per cent part and the rest is of the banks. Also, a foreign investor has taken keen interest and is looking to invest in the company. This will be an interesting turnaround case. It is interesting to note that the market cap of Arshiya was Rs 300-350 crore when we first acquired and today, post restructuring, improved performance and better prospects, it stands at Rs 2,000-2,200 crore. As it can be seen, major part of original haircut taken by the banks has already been recouped through the equity route, plus the company gets back on its feet instead of being dead.
How do you view the ARC framework and business environment?
Every distressed asset must be viewed in the overall context. Steel, for instance, has a cycle and the cyclical part of the business failure must be viewed accordingly. Go back to the history of large steel, cement, fertilizer companies – many of them have undergone corporate debt restructuring (CDR) at some point of time. Macro factors are also important, and we have had a bad economic cycle in 2010-15. This is a key reason why CDRs in this period did not get desired results. The RBI, particularly during Raghuram Rajan’s time tried mechanisms like Joint Lender Forum, which is another CDR version, SDR and S4A. Unfortunately, these schemes did not work due to again the macro environment and to some extent lack of proper monitoring mechanisms.
All this has ingrained the 30-50 per cent haircut arithmetic in lenders’ minds. ARC is an excellent alternative mechanism and banks should take advantage of it. Banks however are wary of the ARCs, mainly because the first transaction cycle was largely asset stripping of junk cases with uninspiring experience of SR redemption. However post-Rajan, an important structural change has come about, where the 5:95 return ratio (ARC and banks) has been changed to 15:85. With this, if an ARC has to put in 15 per cent cash, it would evaluate the case much more carefully and stringently. In the 5 per cent model, ARCs business model was primarily driven by management fee; even in the worst case scenario, ARCs return on its capital was decent. With the paradigm shift from agency model to investment model of business, there are bigger stakes return on its investment which is correlated to the recovery and hence revival model has bigger incentives. Therefore, now the ARC must think beyond the management fee, and have more stringent resolution timelines. For a decent return over investment (ROI) of 18-20 per cent, we must recover 150-160 per cent of acquisition cost. The equity component like the one in the case of Arshiya, is an extra avenue, which of course depends on the improvement of macroeconomic environment, besides the revival of the asset itself.
What is the rationale behind distressed assets fund business in the Edelweiss group?
It is mainly due to the regulatory framework. With our revival-focused approach, we generally find that cases need additional funding, capex or working capital or both. In 2012, the RBI clarified that an ARC could only fund small incremental amounts (25 per cent of total investment). We, hence, found that the last-mile funding for a revival plan was not getting done. That is when we thought that our group could source funding. With higher yield and proper structuring, we were able to bridge the funding gap. That is how the alternative investment fund emerged, with the CDPQ line of credit and operational turnaround team. In cases like BILT Graphic, Karaikal Port, etc., there was an additional investment need of Rs 300 crore, for which outside funds were naturally needed. This was a distressed assets opportunity for us in our alternative investment fund. For the company, we are a total solutions business, complete with operational assistance. We foresee being able to discuss some more successful resolution cases in the next couple of years.